Well, well. Ratings agency Moody's (NYSE: MCO) got a so-called Wells notice from the SEC and thought it was OK to keep it hushed up until it was forced to say something in its quarterly report. It's bad enough to be thought of as part of a rat pack foisting risky investments on an unwitting market; must executives really go and burnish their bad-boy image by trampling over good governance, too?

Falling down the Well(s)
A Wells notice is a precursor to a civil lawsuit in an SEC investigation. It outlines for the person or company getting the letter what charges the regulatory agency might file and gives them a chance to mount a defense.

Companies typically give investors a heads-up when they're under investigation. Last October, brokerage house Schwab (Nasdaq: SCHW) got a Wells notice relating to two of its fixed-income mutual funds and announced the action the same day. Financial services firm State Street (NYSE: STT) issued a notice within four days of learning the SEC was targeting it, while First Horizon National (NYSE: FHN) waited a week to disclose its notice.

The company you keep
Of course, if you're posturing as an outlaw biker, as Moody's apparently is, you can't go wrong siding with one of the most vilified investment banks out there. Goldman Sachs (NYSE: GS) is under fire because it got a Wells notice last September and neglected to mention anything until the SEC finally brought fraud charges against it. Seems when you're busy doing "God's work" you can't let something as trivial as a civil lawsuit get in your way.

While there is no requirement that a company disclose receipt of a Wells notice, a company needs to consider whether the action is material to its business. In the Schwab case, for example, it only dealt with two of its mutual funds and was unlikely to threaten the entire company's existence, but it still disclosed the notice right away.

In Moody's case, the SEC alleges that the company's application to become a nationally recognized statistical rating organization contained "false and misleading" information. The government agency alleges that members of a committee overseeing a type of European derivatives investment failed to modify inflated ratings that were due to software issues. If the SEC is successful in this case, Moody's rating business would be busted.

Some might consider that to be material information, particularly the investors who put money into the company in the weeks between when Moody's got the notice in March and when it finally got around to publicizing it in May.

Heading for the exits
Worse for Moody's image, its CEO decided to set up a trading plan to unload his stock just a month before the company received the Wells notice. It apparently wants us to believe CEO Raymond McDaniel was operating in a vacuum and was unaware the SEC was investigating the firm. It sure doesn't look good that he unloaded some $4.3 million worth of stock the same day Moody's was served.

Although Berkshire Hathaway (NYSE: BRK-A) was also a big seller then, dumping about a million shares worth more than $30 million, Warren Buffett's action is not so suspect because he's been selling down his stake in Moody's for some time.

Jailhouse rock
Whether or not the SEC carries through on its threat, Moody's had an obligation to inform investors it was under investigation. At best, it will be distracted by having to defend its actions. At worst, it could end up getting shanked by regulators.

Jailhouse scars are appropriate on outlaws and thugs, not on the companies we invest in.